During the late 1970s people who saved their money at mortgage lending institutions began withdrawing their deposits from these institutions. The disadvantages of saving in the mortgage lending institutions were hurting the investor’s returns. In order to achieve more profitable returns, these traditional savers started investing in high-yield money market mutual funds and other various markets (Brewer III, 1980). With money leaving the mortgage lending institutions, the housing markets were being squeezed. This squeeze on banks, felt in some states, caused banks to cut off credit to households, farmers, and small businesses. Also, during this time only depository institutions were required to maintain non-interest bearing reserves with the Federal Reserve Bank (Allen & Wilhelm, 1988). This caused a record number of banks giving notice of leaving the Federal Reserve in order to be more competitive in the markets. Toward the end of the 1970s inflation was at a high level along with the interest rates. The culmination of these events along with other events called for new legislation to be written.
The Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA) was signed into law by President Jimmy Carter on March 31, 1980. DIDMCA was considered, by many, as the largest change in the financial industry since the Federal Reserve Act in 1913. Two of the major sections of DIDMCA are Titles I and II. Title I, known as the Monetary Control Act of 1980, sets new standards in reporting requirements, reserve requirements, pricing for services, and sets effective dates. Title II, known as the Depository Institutions Deregulation Act of 1980, sets to create establishment and authority of committee, give directive to the committee, establish targets, reports, and termination of deposit interest rate ceilings (Federal Reserve Bank of Boston, 1980). DIDMCA also allowed the Savings and Loans Institutions to invest up to 20 percent of their assets in consumer loans, commercial paper, and corporate debt securities (Allen & Wilhelm, 1988) (Visser & Wu, 1989) (Moysich, 1997).
Empirical research conducted by Allen and Wilhelm (1988) assesses the impact of DIDMCA within three different types of depository institutions. Allen and Wilhelm used intervention analysis on each portfolio, FRS banks, non-FRS banks, and Savings & Loans (S&Ls). The study concluded that the FRS banks exhibited a gain of 3.9 percent and the non-FRS and S&L’s portfolios lost 4.3 percent and 4.4 percent, respectively. This research indicates that the passage of the DIDMCA, in one respect, was a way to redistribute wealth back into the FRS banks at the expense of S&Ls and non-FRS banks. However Allen and Wilhelm’s research only focused on weekly returns for 179 weeks before and only 30 weeks after the enactment of DIDMCA on March 31, 1980. A better example may come from a long term study of the industry.
Other research, such as Visser and Wu’s (1989) study on the effects of deregulation on bank stock price-earnings ratios (P/Es), set to determine the price-earnings ratios within the banking industry after a major legislative event, like DIDMCA. The study was run over a 10-year period, from 1976 to 1985. The study highlights the variables known to influence P/Es and of the nine titles of DIDMCA only Title IV appeared to have unambiguously negative effects on the P/Es of large banks. Title IV increased the powers of thrifts, which potentially can lower expected earnings for banks as thrifts penetrate their markets. Visser and Wu concluded that the DIDMCA significantly raised the P/Es of large banks, caused them to fluctuate more, and fundamentally changed the way in which they are determined. With P/Es raising investors are left paying more for each unit of stock.
DIDMCA increased the amount of deposit insurance covered by the FDIC from $40,000 to $100,000. This increase in insurance allow for an increase of risk and “moral-hazard.” This increase of the FDIC insurance and deposits interest rates were established to alleviate disintermediation, or the flow of deposits out of financial institutions into money market mutual funds and other investments (Moysich, 1997). The deregulation and increase of “moral hazard” lead to a growth in the S&L industry. From 1980-86 the S&L industry saw a rise of nearly 500 new charters, and the S&L stock contributed to 21 percent of the industry. The percentage of S&L assets in mortgage loans, from 1981-1986, dropped from 78 percent to 56 percent. S&L assets were insolvent and a bailout was not too far away.
Summary
With the onset of increasing competitions between the different financial institutions, investors pulling deposits out of deposit institutions for more lucrative returns, banks pulling out of the Federal Reserve, and decades without financial reform, the need for a financial overhaul was inevitable. Starting from the beginning of the 1980’s, deregulation and moral hazard lead to S&L crisis. As congress fights on to create a new set of financial reform, I hope they have all learned that deregulation is not reform. I believe banks need to be able to fail; this will separate the strong from the weak. If people wish to gamble their money in risky stocks then they should be able to lose, after all it’s a gamble not certainty.
References
Allen, P. R., & Wilhelm, W. J. (1988). The Impact of the 1980 Depository Deregulation and Monetary Control Act on Market Value and Risk: Evidence from the Capital Markets. Jorunal of Money, Credit, and Banking , 364 - 380.
Brewer III, E. (1980, September 11). The Depository Institutions Deregulation and Monetary Control Act of 1980. Retrieved June 22, 2010, from ChicageFed.org: http://www.chicagofed.org/digital_assets/publications/economic_perspectives/1980/ep_sep_oct1980_part1_brewer.pdf
Federal Reserve Bank of Boston. (1980). Depository Institutions Deregulation And Monetary Control Act of 1980. Retrieved June 22, 2010, from Bos.FRB.org: http://www.bos.frb.org/about/pubs/deposito.pdf
Moysich, A. (1997). The Savings and Loan Crisis and Its Relationship to Banking. Retrieved June 22, 2010, from FDIC.gov: http://fdic.gov/bank/historical/history/167_188.pdf
Visser, J. R., & Wu, H.-K. (1989). The Effects of Deregulation on Bank Stock Price-Earnings Ratios. Financial Analysts Journal , 62 -67.
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